TIME

Why Buffett Should Vote ‘No’ on Coke

Berkshire Hathaway Inc. CEO Warren Buffett Interview
Warren Buffet Chris Goodney—Bloomberg/Getty Images

The discussion over inequality is all the rage these days, and it’s been given a new wrinkle with the hoopla over Warren Buffett’s abstention from a vote over Coke’s new compensation plan, which would award billions of dollars to Coke managers in Coke stock if they hit certain performance targets. Buffett told CNBC that he opposed the idea, but wouldn’t directly vote against it, because he loved the company, which was run by “great people” (which, it must be said, includes his son, who sits on the firm’s board). Traditionally, Buffett has opposed excessive corporate compensation, as well as the stock buyback plans that often fuel oversized packages, because, as he said in a 1999 letter to shareholders, “repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price.”

I couldn’t agree more, and I wish he’d gone further and actually voted “No” to the Coke proposal. Pumping up corporate compensation with excessive stock deals fuels not only inequality but bad decision making (since executives are incentivized to do things that pump up prices in the short term but cut growth in the longer term.

Buy backs are a case in point. Even more than in the late 1999s, buybacks are all the rage right now. University of Massachusetts professor William Lazonick, who studies the effects of buybacks on corporate compensation and inequality, recently put out a paper showing that between 2003 and 2012, 449 of the S&P 500 companies gave out more than half of their earnings, some $2.4 trillion, on buying back shares of their own company. While this might seem like a vote of confidence, it’s hardly coincidental that his research shows that buybacks also tend to go hand-in-hand with lower future earnings and bull markets. Companies don’t buy back stock in down markets because they believe that the market has undervalued their great products and ingenuity; they do it in bull markets because they want to bolster their own pay at a time when underlying growth is sagging.

It’s a strategy being carried out today at companies like Apple, which just announced more share buybacks even as it announced lower earnings, and at Yahoo, which has offset an underwhelming growth story by buying back stock. It’s happening at Coke, too, and most of the country’s largest blue chip firms. It’s no wonder that execs want to be paid in stock – buybacks almost always bolster share prices over the short term, and investment income like stock makes you a lot richer than earned income from actual labor. It also decreases the amount of the economic pie that goes to labor versus management.

All this worries me. If you chart the rise of share buybacks against R&D spending in corporate America since the 1980s, the lines make a perfect X. We are very clearly bankrupting our future growth here. As Lazonick puts it, “Since the mid-1980s, corporations have funded the stock market rather than the market funding corporations.” Not to mention workers, or jobs (most large American corporations have had zero net job growth here at home over the last 30 years, even as corporate pay has risen to nosebleed levels). No wonder Thomas Piketty’s book on inequality and the triumph of capital over labor is at #1 on Amazon.

TIME

Here’s Why This Best-Selling Book Is Freaking Out the Super-Wealthy

FRANCE-ECONOMY-PIKETTY
Thomas Piketty FRED DUFOUR—AFP/Getty Images

There are many reasons why French academic Thomas Piketty’s 685-page tome, “Capital in the 21st Century,” has vaulted to the top of the Amazon.com best seller list and is being discussed with equal fervor by the world’s top economic policy makers and middle class Americans who wonder why they haven’t gotten a raise in years. The main reason is that it proves, irrefutably and clearly, what we’ve all suspected for some time now—the rich ARE getting richer compared to everyone else, and their wealth isn’t trickling down. In fact, it’s trickling up.

Piketty’s 15 years of painstaking data collection—he poured over centuries worth of tax records in places like France, the U.S., Germany, Japan and the U.K—provides clear proof that in lieu of major events like World Wars or government interventions like the New Deal, the rich take a greater and greater share of the world’s economic pie. That’s because the gains on capital (meaning, investments) outpace those on GDP. Result: people with lots of investments take a bigger chunk of the world’s wealth, relative to everyone else, with every passing year. The only time that really changes is when the rich lose a bundle (as they often do in times of global conflict) or growth gets jump started via rebuilding (as it sometimes does after wars).

This is particularly true in times of slow growth like what we’ve seen over the last few years. I’ve written any number of columns and blogs about how quantitative easing has buoyed the stock market, but not really provided the kind of kick that we needed to boost wage growth in the real economy, because it mostly benefits people who hold stocks–that’s the wealthiest 25 % of us. Meanwhile, consumption and wage growth remain stagnant. And as Piketty’s book makes so uncomfortably clear, it’s likely to get worse before it gets better. No wonder I saw an advertisement for a storage company on the subway the other day that read, “The French aristocracy didn’t see it coming, either.”

That’s one of Piketty’s biggest messages–inequality will slowly but surely undermine the population’s faith in the system. He doesn’t believe, as Marx did, that capitalism would simply burn itself out over time. In fact, he says that the more perfect and advanced markets become (at least, in economic terms), the better they work and the more fully they serve the rich. But he does believe that rising inequality leads to a less perfect union, and a likelihood of major social unrest that mirrors the sort that his native France went through in the late 1700s. Indeed, the subsequent detailed collection of wealth data in the form of elaborate income and tax records made France a particularly rich data collection ground for his book. (Bureaucracy is good for something!)

My feeling about this book is similar to that of New York Times’ columnist Paul Krugman. It’s going to be remembered as the economic tome of our era. Basically, Piketty has finally put to death, with data, the fallacies of trickle down economics and the Laffer curve, as well as the increasingly fantastical notion that we can all just bootstrap our way to the Forbes 400 list. It’s telling and important that Piketty credits his work to the fact that he didn’t forge his economic career in the States, as so many top thinkers do, because he was put off by the profession’s obsession with unrealistic mathematical models, which blossomed in the 1980s to the exclusion of almost all other ideas and disciplines, and the false ideologies that they were used to justify. “The truth is that economics should ever have sought to divorce itself from the other social sciences and can only advance in conjunction with them,” he argues.

Indeed, had more top economists followed the lead of other social scientists and ditched their black box models in favor of spending time in the field—meaning on Main Street, where trickle down theory hasn’t ever really worked—they might have come to the same conclusions that Piketty has. We can only hope that the politicians crafting today’s economic programs will take this book to heart.

TIME

The Digital Economy Is Profoundly Unequal

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Getty Images

Is unbridled innovation good for society? Can we trust the internet? Can we afford not to? These are some of the big picture questions being asked right now at the annual Institute for New Economic Thinking conference in Toronto. It’s a George Soros-sponsored academic shindig that has become a touchstone for the key economic policy conversations in the year ahead. This year, the topic is how to manage the societal fallout from our rapidly expanding digital world. At a time when much of what happens on the internet–from NSA snooping to runaway viruses like the Heartbleed bug to cyber-warfare with China–makes people scared, how do we craft a digital world that feels safer and more secure? And how can we make sure that the benefits of the digital economy–which currently accrue mostly to the top quarter of society–are more equally shared?

I discussed these issues with Quartz editor Kevin Delaney and the Guardian’s Heidi Moore, this week on WNYC’s Monday Talking (listen below). And I’m listening to some of the world’s top thinkers on the topic debate them here in Toronto. One of the things that I’ve found fascinating so far is how unequal the digital economy really is. Yesterday, University of Michigan professor Lisa Cook gave an illuminating (and somewhat depressing) presentation about this. For starters, innovation is making our economy more bifurcated. People who make their living interacting with technology and the digital world make a median salary of $74,000 a year. Those that don’t make $34,000. Women and minorities (with the exception of Asians) lag behind. 70 % of people in the “innovation economy” are non-Hispanic whites. And even for women with technology degrees, there’s a big pay differential. Men in the innovation economy make $80,000 per year and women make $53,000, in part because they tend to be concentrated in areas like life sciences, which pay less than physics or engineering or computer science.

So, what to do? Cook says the good news is that there’s reason to think that more diversity is good for business, and that can help drive change. Her research shows that co-ed patent teams, for example, are much more productive than single sex ones. And while pipeline issues used to be a big problem, women are getting more and more STEM degrees – roughly 40% of them now go to women, up from around 9% in 1970. Now, female entrepreneurs just have to start monetizing those educational gains. Cook says that women are founding less than 5% of new tech start-ups. All I can say is follow the money, sisters!

TIME

Can $68 Billion Make Wall Street Any Safer? Nope

This week, U.S. financial regulators announced that Too Big To Fail (TBTF) banks will be forced to increase their capital cushion by $68 billion, to comply with new financial reform rules. But if you think that’s going to finally make our financial system safe, you are wrong. At least, that’s the verdict from an all-star panel that spoke on the topic of financial stability on Thursday at the Institute for New Economic Thinking annual conference, being held this year in Toronto.

The panel was made up of a diverse group of heavy-weights: Andy Haldane, head Bank of England’s stability board, Stanford professor Anat Admati (author of “The Banker’s New Clothes”), Richard Bookstaber from the U.S. Treasury’s Office of Financial Research, and Boston College professor Edward Kane. What’s disturbing is that they all came to the same conclusion—not only have we not repaired the financial regulatory system since Lehman, but we may have made things worse by creating a complicated spaghetti bowl of new rules that don’t actually address the fundamental problem. (Those would be Dodd-Frank and Basel III.) Banks need a lot more money, and the financial lobby needs a lot less.

Haldane, one of the most influential voices these days in economic policy circles, laid out the situation with stark numbers showing that, amazingly, global TBTF banks are bigger, more complicated and riskier than before the crisis. In 2006, for example, such banks held $1.3 trillion on their balance sheets. Today, they hold $1.7 trillion. Back then, they held $19 trillion worth of derivatives, those “weapons of financial destruction” that Warren Buffett complained about. Today, they have $31 trillion. Thanks to the Fed’s post crisis low interest rate policy, they pay less than ever to borrow money, which means that debt is cheap. That’s one reason the amount of debt held by such banks is still about 21 times their assets. Yes, those “leverage ratios” are lower than the 32X average in 2000. But holding that much in liabilities means that if asset prices go down even 5%, banks will once again be in the gutter. And history shows that happens about once ever 20 years–meaning, if big banks don’t put away a lot more capital, we can look forward to another Lehman Brothers event in our lifetime.

Which kind of puts this week’s capital announcements in context. Sure, it’s great that banks are being required to hold 5% of their own cash, rather than the usual 3%. But no other business in America, not to mention individuals, would be able to survive with a balance sheet that looked like this. Bankers would argue that things have changed hugely from the pre-crisis days till now. After all, the CEOs of the world’s top banks got paid an average of $20 million a year back then (many U.S. chiefs got more), and only $9 million now. Yet the value of these banks’ stock has plummeted over that time, as has their asset base. If you look at pay as a percentage of assets, it’s now 42%—3 percentage points higher than it was back in 2006.

What’s the solution? The panelists had plenty of ideas. Make banks hold a lot more cash–more like 25% of their balance sheet. Make risk models, which are amazingly simplistic given the complexity of the global financial system, a lot more sophisticated. And make financial institutions pay criminally for bad behavior. The U.S. Supreme Court’s Citizen’s United decision, which gave corporations the same rights as people, paved the way for ever more lobbying money to make its way into our system. (Some 96 % of all Dodd-Frank consultations were taken with bankers themselves, which is perhaps one reason the system looks as ineffectual as it does.)

If companies get the upside of being people, they should get the downside too, argued Ed Kane. That means prosecution for malfeasance, and punishments like being split up if they take on risk that leads to a taxpayer bailout (no, nobody believed the current Dodd-Frank promises of no more bailouts would actually hold in a financial crisis). It may sound wacky–but so does the fact that bankers are getting more pay per dollar of assets today than they were before they wrecked our financial system.

TIME

Sam Palmisano’s Advice to Younger Tech Titans: Don’t Show Up to Davos in a Hoodie

Dell & IBM CEOs On Technology, Innovation, and Deficit Reduction
Samuel "Sam" Palmisano, former chief executive officer of International Business Machines Corp. (IBM). Bloomberg—Bloomberg via Getty Images

IBM has been, in many ways, the Teflon tech company. At a time when big Silicon Valley firms like Apple, Google, Yahoo and others have been under fire for everything from tax avoidance, to offshoring, to playing fast and loose with privacy, the 101 year old Armonk, NY giant has managed to look like the model for socially responsible business. It has garnered good press for everything from its educational initiatives, to its support for local supply chains in the U.S. Its Smarter Cities initiative, in which it works with local leaders to knit together public transport, economic development, energy, and digital strategies is another example of how the company deftly manages to bridge the global/local divide.

A good chunk of the credit for this goes to former IBM CEO Sam Palmisano, who led the company between 2003 and 2011, during which time it achieved record performance, in part by successfully shifting its business model from hardware to services, but also for connecting social goals in areas like education, health and safety with revenue building, under the “Smarter Planet” strategy. Basically, IBM figured out not only how to make money serving local governments by building out city infrastructure, providing products and services in schools, hospitals and elsewhere, but how to avoid some of the globalization backlash that typically plagues big tech companies with fat margins and multinational reach.

I’ve always been interested in how the company pulled all this rare feat off. That story is one of the things that Palmisano is touting in his new eBook, Re-Think: A Path to the Future, which is meant to be a roadmap for how to build a 21st century multinational. The title is unsexy, and, truth be told, so is much of the book itself. But Palmisano, who is now a director at the Center for Global Enterprise (which aims to research and roadmap the practices of the most successful and sustainable firms around the world, from family owned businesses in Germany to American blue chip multinationals) does have some interesting insights and old school corporate wisdom that the younger generation of Silicon Valley techies, as well as any number of other corporate leaders, should pay attention to. Below, his five most interesting takeaways:

  1. “Don’t show up to Davos in a hoodie.” That was Palmisano’s tongue in cheek answer to my question about why tech is no longer Teflon. But his point is actually serious. Too many corporate leaders are inward facing, focused mainly on themselves and their own corporate cultures. 21st century leaders are going to be dealing with a much broader range of stakeholders – both public and private – in a bigger array of geographies than ever before. It’s important to reflect and understand those cultures, not just your own.
  2. Localnomics matter. The brilliance of IBM’s Smart Planet strategy is that it’s totally global, but feels local. “To succeed as a globally integrated enterprise today, you have to connect with the local agenda,” says Palmisano. Smart Planet allows IBM to embed its products and services in local schools, sanitation services, hospitals, and power companies. They become a go to player in providing basic public services – thus building trust in local communities.
  3. Cities are more important than countries. They are where over 50% of the world’s population, and most of its money, is. “Life comes together in cities, not in countries,” says Palmisano. IBM builds its business around the biggest and most important ones.
  4. Values can be motivational. When he was faced with the challenge of trying to get a bunch of patent holding IBM engineers who’d spent a lifetime building a PC business to ditch that and come up with a new technology strategy around services, Palmisano issued a challenge: “What can this company do to create a safer and more secure society?” The result, after several years, was Smart Planet. Of course, it didn’t hurt that he threw $100 million in blue-sky money at them to help develop promising ideas.
  5. Which goes to the final point – think long-term and ignore the bankers. When Palmisano realized the company had to evolve or die, back in 2006, he decided to take a radical step and refuse to issue quarterly earnings guidance to the Street. “I knew we had a good plan, but I also knew we needed time to execute it, and it was going to be tough to have the operational flexibility we needed,” with Wall Street analysts watching for an earnings bump every few months. The long-term thinking paid off – two years later the stock soared. Palmisano believes more companies, particularly high performing ones, should make the same decision. “If you are trying to squeeze a few more cents out every quarter, it can be hard to make the best long term decisions.”
TIME China

China’s Growing Debt Problem

A new hurdle for the world’s second largest economy

One of the most telling economic events since the financial crisis has gone almost entirely unnoticed. A few weeks ago, China had its first corporate-bond default. The company in question, a solar-energy-equipment firm called Shanghai Chaori, was small, private, highly leveraged and not very important. But the default speaks volumes about the state of the world’s second largest economy. China is in the middle of a debt crisis the likes of which we haven’t seen since the fall of Lehman Brothers. Chaori’s default was tiny by comparison. It couldn’t make a payment on a $163 million bond; Lehman owed $613 billion when it folded. But it’s the tip of an iceberg that is now nearly double the size of China’s GDP. By allowing Chaori to go bust, the Chinese signaled they’re no longer in denial about the problem.

That matters in a country in which statistics are precooked and every economic move, even the run-up in debt itself, is planned. Back in December 2008, I met in Beijing with Jiang Jianqing, the head of ICBC, China’s largest financial institution. He acknowledged that the massive government stimulus program that was put in place to cope with the global slowdown would result in a higher percentage of bad Chinese loans. After all, when Beijing says, “Lend,” state-owned banks ask, “How much?” even if borrowers aren’t creditworthy. China’s biggest banks wrote off more than twice the level of bad loans last year as they did in 2012.

That’s no surprise given the size of China’s debt bubble. Over a year ago, Ruchir Sharma, head of emerging markets for Morgan Stanley Investment Management, pointed out that China was pumping out credit faster than any other country. The problem: much of it went into dubious public-sector investment (unneeded rail lines and housing projects) rather than productive private enterprises. Five years ago it took just over a dollar of debt to create a dollar of economic growth in China. Today it takes four dollars of debt to create a dollar of growth. Those are crisis numbers by any standard.

A financial crisis in China isn’t the same as one in the U.S. For one, Chinese debt is almost completely Chinese-owned. A large chunk of it is in the public sector, and the central government, which holds some $4 trillion in reserves, can bail out firms at will. Indeed, as the Conference Board’s China economist Andrew Polk points out, they’ve done that more than 20 times in the past two years, a measure of how long the crisis has been brewing. “It will be difficult for China to have a Lehman moment,” he says, “because China can always find a buyer of last resort somewhere in the state system.”

That sounds good, but it also means China can let its debt crisis fester. That will only make things worse in the long run, increasing moral hazard and slowing economic growth, which may be as low as 5% this year. (That’s down from double digits a few years back.) Worse, the government is already using those figures as a reason to backtrack on its recent promises to reform the economy. Beijing is now talking about more stimulus to keep the country’s growth rate up around the 7% it says is needed to keep unemployment from reaching dangerous levels. China’s leaders fear unemployed masses taking to the streets: historically in the Middle Kingdom, those sorts of events tend to end with people being paraded around and then shot.

Trouble is, the argument that more debt is needed to keep unemployment down no longer holds water. As Sharma points out, every percentage point of GDP growth now creates around 1.7 million new jobs–up from 1.2 million a decade ago. Also, fewer young people are coming into the workforce as the population ages. That means even 5% growth would likely keep the Chinese economy stable. So why isn’t the country doing more to deflate its debt bubble and change its economic model? Because as in the U.S., the political and economic elite have little impetus to change a system that has made them fantastically wealthy.

That’s the real economic risk factor in China right now. While Beijing may allow firms like Chaori, which are not systemically important, to go under in order to convince people that it’s grappling with the debt issues, provincial governments and state-owned companies are still too big to fail. That might not result in a Lehman Brothers moment. But it will make it harder and harder for the country to move to its next stage of economic development, which, given that China has represented about a third of global growth since the 2008 financial crisis, has implications for us all. Will China be a drag or a boon to the global economy? Perhaps more than at any other time since the country began its transition to capitalism some 30 years ago, the answer is as blurry as the air in Beijing.

TIME

The Rise of Finance and the Fall of Business

Two of the biggest business news events of the moment—GM’s ignition switch scandal and the hoopla over Michael Lewis’ new book about high frequency traders—actually have roots in the same issue: the financialization of America. This is a topic I’ve been fascinated with for some time. As finance and financial thinking have grown more and more dominant in our business landscape over the last several decades, you are seeing all sort of systemic problems, from the triumph of the bean counters over the engineers at GM to the rise of trading that enriches only the trader, rather than society. I feel strongly that the financialization of American business is leading to short term thinking and a huge variety of problems—everything from the focus on share-buybacks over R & D spending in so many Fortune 500 companies, to the fact that we have a tax code that treats gains from short term trading the same way it does those from long term holdings. I can only conclude that this is a trend that will continue. The latest Bureau of Economic Analysis numbers out earlier this year show that finance as a percentage of our economy is once again creeping back up. NYT columnist Joe Nocera and I discussed this and more on this week’s episode of WNYC’s Money Talking, here:

TIME

Give Mary Barra a Break: Leave Gender Politics Out of the GM Scandal

General Motors Co's new chief executive Mary Barra addresses the media during a roundtable meeting with journalists in Detroit, Michigan in this file photo from January 23, 2014.
General Motors Co's new chief executive Mary Barra addresses the media during a roundtable meeting with journalists in Detroit, Michigan in this file photo from January 23, 2014. Reuters

At the risk of sounding like a GM apologist—which I am definitely not, see here—I have to say that I was disappointed in the political grandstanding of many of the Congress members who grilled CEO Mary Barra over GM’s faulty ignition switch scandal which has resulted in a number of deaths and accidents. In particular, I found Senator Barbara Boxer’s statement that she was “very disappointed, really, woman to woman” in Barra dismaying.

There’s no question that GM’s performance has been concerning. The evidence presented in the hearings over the last couple of days made it clear that the company knew about problems with the ignition switch and made a decision not to do a recall or change the part prior to rolling out vehicles. Whether this was a cynical decision made by some malevolent bean-counter, or simply the result of a company that was, as Barra put it, full of “silos” that didn’t talk to one another, remains to be seen. Much hinges on the results of the federal investigation into the matter.

Until then, though, could we please leave gender politics out of the discussion? Not only is there no evidence that Barra knew anything at all about the issue, I hate hearing comments like the one Boxer made, which make it seem like Barra has some special, higher calling as a woman leader. That sort of comment is just as sexist as the opposite sort that might have been made in the days of Old Detroit. For my money, Barra has performed admirably in a tough situation, being reasonably transparent, saying she doesn’t know things when that’s actually the case (imagine – a corporate leader being straight and frank!), and generally setting a standard for crisis management.

Of course, if we find out in the course of the investigation that she knew something about the problem or was in any way part of the culture of secrecy and bean-counting that seemed to characterize the old GM, I’ll be eating my words. ( I doubt that will be the case; the company probably wouldn’t have put her front and center of the scandal even prior to the Congressional hearings if she did.) But if that turns out not to be the case, I’m wondering if she may become the model for a new kind of post financial crisis CEO. Prior to 2008, we had a decade of celebrity CEOs. After 2009, America’s corporate leaders just wanted to keep their heads down and stay on script. Now, Barra is front-and-center, acting not like a talking head or a corporate drone, but a real person. If she manages to bring her company out of this crisis, and create a new corporate culture for GM, Boxer may be the one eating her words.

TIME

Here’s Who Is Really to Blame for the Epic GM Scandal

2005 Chevrolet Cobalt SS
The 2005 Chevrolet Cobalt SS is displayed on the floor of the North American International Auto Show in Detroit Michigan, in this file photograph taken January 5, 2004. Gregory Shamus—Reuters

It’s a revelation that has people’s hair standing on end. In yesterday’s Congressional testimony on the GM ignition switch scandal, it was revealed in a 2005 email that a decision had been made not to replace the switch (which was known to have problems) because it would cost the company 90 cents per switch to do so. No wonder CEO Mary Barra, who very likely had nothing to do with any of this but is still left holding the bag, has called in Kenneth Feinberg, the lawyer who handled the victim’s funds for 9/11 and the Gulf of Mexico oil spill, to deal with the potential payouts to victims of accidents caused by the faulty switches.

The fact that the bean-counters seem to have won out over the quality control and design factions at GM puts me in mind of a book review I did in 2011 on former GM vice-chair Bob Lutz’s Car Guys Versus Bean Counters: The Battle for the Soul of American Business. In it, Lutz wisecracks his way through the 1960s design- and technology-led glory days at GM to the late-1970s takeover by gangs of MBA’s. Executives, once largely developed from engineering, began emerging from finance. The results ranged from the sobering (managers signing off on inferior products because customers “had no choice”) to the hilarious (Cadillac ashtrays that wouldn’t open because of corporate mandates that they be designed to function at -40°F). It’s pretty easy to imagine Car Guy Lutz removing his mirrored shades and shouting to the cowering line manager, “Well, customers in North Dakota will be happy. Too bad nobody else will!”

GM’s problems today, of course, aren’t funny. And neither is the history of the triumph of bean counters over car guys in the auto industry. It’s a history that has deep roots that go all the way back to the 19th century, to the invention of the numerical religion known as “efficiency theory” by Frederick Winslow Taylor. Its core concept—the notion that anything which can be measured can be managed—was picked up and re-popularized by Henry Ford but also one-time Ford CEO and former Secretary of Defense Robert McNamara.

The last several decades of economic and business history might have been quite different if not for McNamara, who, under President John F. Kennedy and later Lyndon Johnson, was largely responsible for the failure of U.S. strategy in Vietnam. His obsession with systems analysis—in which data about every aspect of the war effort, from bombs to defoliants to fatalities to the number of enemy vehicles disabled per airstrike megaton was collected in order to maximize efficiency—blinded leaders to the overall strategic failures of the war effort. Since it was impossible to argue with numbers, it was difficult to question McNamara’s thinking, a topic well described in books like The Best and the Brightest.

But a less well-known aspect of McNamara’s legacy was how he brought financial efficiency theory to corporate America, introducing a culture of management by numbers that eventually undercut productivity in some of America’s top corporations. Long before his ideas shaped the war effort in Vietnam, McNamara launched an attack on Ford, where he developed a mania for squeezing fractions of pennies out of the cost of a set of front-wheel lug bolts, while ignoring the creative side of the company, a strategy which eventually led the automaker to lose its global dominance. It’s a legacy that’s being felt within the industry even today—in fact, I’d say that GM’s current recall scandal, in which a decision to save 90 cents on an ignition switch led to numerous deaths and a Congressional investigation, can be traced all the way back to the ideas that McNamara popularized in the industry.

The streamlining of Ford was orchestrated by the “Whiz Kids” who came out of the Pentagon’s statistical analysis department, of whom McNamara was the best known. Hired by Henry Ford II himself, the Whiz Kids cut costs and bolstered the company’s stock price, but also undercut investment in product development, which resulted in a decline in overall productivity at the company from 1965 onwards. Managing by numbers became endemic in corporate America as the Whiz Kids went on to run many more Fortune 500 firms.

The result was a loss in international competitiveness on the part of American firms as a whole as Whiz Kid notions of quantitative, cost-driven management came to dominate business education in America. (Harvard Business School in particular built its curriculum around these ideas.) Yet as the number of MBAs and management consultants in corporate American rose (“if you can measure it you can manage it” actually became known as the McKinsey Maxim), U.S. business actually lost much of its innovation mojo.

As the GM scandal shows, we are all living in the green eyeshade-tinted world of Robert McNamara today, a world in which numbers all too often get in the way of really good ideas – or even the value of a human life.

 

TIME wall street

High-Speed Trading Is Turning Wall Street Into a Casino

Everyone is talking about Michael Lewis’ new book, Flash Boys: A Wall Street Revolt. The book basically calls into question whether high-speed trading, used by geeks and money men alike to front-run the market, is even legal. Whether or not it is, many of us would agree that ultra-short-term trading of this sort isn’t what the markets were intended to foster. And indeed, it’s particularly sad that many of the people who develop flash trading programs are math PhDs that might instead be creating, say, green turbine engines or solving global warming or doing something a lot more useful than building trading technology to make rich guys even richer.

All of this reminds me of the first time I heard about the inside details of high frequency trading, from a friend who used to do it for a major financial institution. He explained how he built computer programs that would spot where the little “fish” in the market were headed, and then throw some false bait to them. Meaning, in other words, that his very large institution would throw a little cash into whatever trades they were interested in, to further excite the feeding frenzy. Then the big institution’s more sophisticated trading systems would kick in to eat their lunch with a better trade on the other side of the pond. That’s somewhat different from what Lewis’ describes, but it’s all part of the same phenomenon—trading for trading’s sake, and financial transactions that represent value only for the trader, rather than for the companies or assets being traded, or society at large.

It’s not what Adam Smith had in mind when he extolled the virtues of the market’s invisible hand. But given that our tax system doesn’t penalize anyone for short-termism (high-speed trading gains are taxed at the same rate as any other investment gain), it’s no wonder that this kind of trading is growing, creating market volatility and costing institutions and individual investors hundreds of billions in lost wealth. The entire value of the New York Stock Exchange now turns over roughly every 12 months, a rate that has doubled since the early 1990s. As Warren Buffett once told me, “You’ve got a body of people in the market who’ve decided they’d rather go to the casino, rather than the restaurant.”

I hope the Lewis book leads to a rethink of the legality of trading—because it’s costs don’t just end with markets themselves. This rise in trading and particularly high-speed trading has coincided with a decrease in the amount of lending to small and mid-sized businesses. It’s no surprise why: effective lending is expensive and time-consuming. You have to know your customer and your industry, which takes time, money, and research. Trading, especially when you can work mainly with borrowed money and massive volume, is much more profitable. Any Flash Boy can tell you that.

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